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Bond Buyers Can't Get No Satisfaction in Long Treasuries

(Bloomberg) -- As the fastest U.S. inflation in a year converges on the flattest Treasury yield curve in a decade, long-dated debt is the last place many investors want to be.

Instead, they are scouting for alternatives that offer the prospect of better returns in an environment of increasing price pressures. Pacific Investment Management Co. is shunning long-maturity Treasuries in favor of shorter tenors and Troy Asset Management is long U.S. inflation-protected debt, while Aviva Investors also favors such securities issued by Japan and France.

Global inflation-linked bonds are gaining appeal at the cost of long-dated Treasuries as President Donald Trump’s tax cuts and $300 billion spending plan threaten to spur consumer prices and increase the supply of debt. Securities protected against an increase in price pressures are also benefiting from conventional German 10-year bonds trading at the most expensive levels versus U.S. counterparts since at least 1989.

“We don’t feel that you’re paid enough to go into longer-duration assets,” said Eve Tournier, head of European credit portfolio management at Pimco. “We prefer certainty, short-term maturities -- which already pay us well without having more mark-to-market risk going into longer-duration assets.”

Duration is a measure of the sensitivity of a bond’s price to a change in interest rates, with shorter or negative duration strategies faring better during periods of rising borrowing costs or inflation. Investors had loaded up on longer-dated debt in the wake of the global financial crisis as interest rates plummeted and inflation stalled.

Flatter Curve

But now, the Treasury yield curve is the flattest it has been since the crisis, with 30-year bonds offering just a 30 basis point premium over their five-year counterparts. While speculators are shorting U.S. bonds across maturities, real money managers are bullish on the belly of the curve, according to CFTC data.

Jeffrey Gundlach’s DoubleLine Total Return Bond Fund is the top performer among intermediate bond portfolios, betting on a shorter-duration strategy, while developed market inflation-protected securities handed investors returns of nearly 5 percent over the past year. That compares to a 0.8 percent loss on nominal Treasuries and a 0.2 percent loss on German bonds, according to Bloomberg Barclays indexes.

Inflation-linked debt is one of the few options that offer value to investors, according to Sebastian Lyon, a fund manager at U.K.-based Troy Asset. He sees little room for further gains in equities or nominal bonds, which have been boosted by unprecedented levels of monetary easing. And while breakeven rates are picking up, price-protected securities also benefit from their relative scarcity, according to Lyon. TIPS, for example, make up just 9 percent of outstanding U.S. debt.

Inflation Protection

“We need some inflation protection,” said Lyon, who has an overweight position in shorter-dated global inflation-linked notes, but would move further out the curve if sovereigns continue to decline. “Linkers effectively have a foot in the bond camp but also in the inflation protection camp as well. There is little supply -- there is a huge amount of debt out there. Not so much inflation-protection debt.”

U.S.-listed exchange-traded funds that offer protection from price increases have taken in about $2.5 billion this year, 6 percent of their assets, according to Bloomberg data. The $24.4 billion iShares TIPS ETF, the largest U.S.-listed passive vehicle that tracks Treasury inflation-protected notes, has taken in $695 million.

Aviva is running long positions in U.S., French and Japanese inflation-linked debt. President Trump’s spending boost and rising oil prices will likely spur price pressures in the U.S., while securities protected against faster consumer-price growth are fundamentally cheap elsewhere, according to money manager Charles Diebel.

“It’s a cyclical story in the U.S.,” he said in emailed comments. “The fiscal spend late in the cycle is adding to the upside inflation risk.”